2d Quarter Client Note

By Steven Smith | Newsletters

Jul 14

There was plenty of noisy global economic and financial news in the second quarter. The Commonwealth of Puerto Rico is teetering on the verge bankruptcy. The Chinese stock market looks like a monopoly game. And the debt negotiations between Greece and the European Central Bank simmer on.

With that backdrop the S & P 500 (Total Return) Index was virtually unchanged – up .28%. International Developed and Emerging Markets fared slightly better; up .48% and .69% respectively.

On the fixed income side, it has been nine years since the last rate increase by the Fed. We know it’s coming – eventually. But the bond market didn’t need any such help in the second quarter. The yield on the ten-year Treasury note increased 42 basis points; sending the Barclays US Aggregate Bond Index down 1.68% for the quarter.

For an in depth review of the quarter’s asset class performance, see the Quarterly Market Review from our friends at Dimensional Fund Advisors; including their take on “the Seven Roles of an Advisor” – none of which, unsurprisingly, includes helping you beat the market.

It’s Greek to Me

Delving into the situation with Greece provides barely a partial understanding of the confounding circumstances making the front pages. And the news changes daily. From a national referendum to closed door meetings in Brussels. To, now, apparently – an agreement.

Cliff Notes of Santorini

Greece has been a debtor nation for good portions of its history. The country entered the Eurozone (i.e., adopted the Euro as its currency in 2001.) Hit particularly hard by the 2008 financial crisis, Greece found a solution to all its problems: borrow more money from the ECB and IMF – to the tune of 240 billion Euros – in exchange for strict austerity measures intended to buy some time and cut Greece’s budget deficit. The result? The country’s GDP has shrunk and unemployment has grown above 25%.

The loans became due and Greece is technically in default. Negotiations have been ongoing for months – with Greece threatening a “Grexit” – leaving the Eurozone and reestablishing the drachma as its currency; something the remaining members would like to avoid. On the other hand, the ECB – and particularly Germany – is wary of letting Greece off the hook, fearing the setting of a bad precedent.

Europe is presented with a painful paradox. Extending current debt terms and infusing more Euros while at the same time imposing increased austerity measures makes it less likely to create the economic growth necessary to repay the debt and may be just kicking the can down the road.

Practical Advice

Greece is a small country with a tiny economy and represents less than .10% of the world’s stock market capitalization. (Meaning, for every $100,000 in your globally diversified portfolio you have maybe $100 invested in Greece.) The one thing I can tell you for sure is that whatever happens, the result will be more difficult for Greece and its citizens than for you.

While it’s impossible to discount to zero the possibility of an eventual contagion if this were to unravel; unlike the financial crisis of 2008, this predicament has been out in the open for years and banks and governments have been able to put some mitigating systems in place.

So, follow the advice of Carl Richards (one of my favorite personal finance writers and author of the new book The One Page Financial Plan) in his recent blog,: “What happens in Greece doesn’t change my financial goals or plans.”

All the Tease in China

China is another country in the news lately. And it’s the wild, wild east. Spurred by plentiful margin loans for Chinese investors, the Chinese stock market rose 60% in the first half of 2015, and more than doubled since mid-2014. Then, in the month from June 12 to July 12, the local market dropped 25%. (Chinese stocks trade on local exchanges, with Shanghai being the largest and also on the Hong Kong exchange for mainland China’s more established companies.) And then…the Chinese government stepped in with trading controls to limit the selling.

China is certainly one of the fastest growing economies in the world. And while China my one day become one of the great capitalist countries with a well regulated, robust and efficient stock market; today its stock market is largely disconnected from the actual economy and functions more like a bazaar or casino.

The market capitalization of China’s equity market is a little over a trillion dollars; comprising approximately 3% of world equity market capitalization and makes up about 25% of the (volatile) MSCI Emerging Market Index. For a US investor with about a reasonable 5% of her portfolio in emerging markets that would put a little over 1% of the portfolio in China. Just about right.

Check In and Check Up

Back in the US, the S & P 500 has nearly tripled since the “Great Financial Crisis” of 2008. Valuations, by any measure, are either near “fair value” or above. How to invest in such an environment?

  • If you’re young, with a long time horizon and just starting out…jump right in and don’t be afraid of corrections, as you have little to lose and they present buying opportunities.
  • If you are middle-aged or beyond, make sure you have a reasonably appropriate asset allocation geared to your personal financial plan and your own need and ability to take risk. Then maintain a disciplined and diversified portfolio. Remember: Rebalancing is not about maximizing returns, but about controlling risk.
  • Keep an appropriate cash reserve for emergencies and short term goals.
  • Prepare emotionally for both lower expected returns and increased volatility.
  • Finally, learn to live with (love?) uncertainty. This bull market will end and we don’t know when or what the correction will look like, nor how long it will last.

And be sure to enjoy the rest of your summer!

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